PRIVATE CLIENT BRIEFING:

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1 PRIVATE CLIENT BRIEFING: I M A US CITIZEN RESIDENT IN THE UK, WHAT DO I NEED TO KNOW? JANUARY 2013 Almost uniquely, the US taxes its citizens (and Green Card holders) on a worldwide basis regardless of where they are resident in the world. This gives rise to a lot of problems and the usual tax and investment solutions for UK domiciled and non-uk domiciled clients are either not viable, or need to be modified. So my estate will be subject to US Estate Tax on death? Yes, it will, whether the assets are in the UK, the US or elsewhere. At present, US Federal Estate Tax for US citizens is charged at 40% on the value above the Credit Amount (the US equivalent of the nil rate band for UK Inheritance Tax (IHT)). The Credit Amount is at present in the region of US$5.25 million (adjusted to account for inflation each year) but it is important to note that this is the combined exemption for both US Federal Estate Tax and US Federal Gift Tax (discussed below). The Credit Amount is transferable between US citizen spouses (to the extent unused by the first spouse to die) provided an election is made at the appropriate time. So if my estate is worth less than the Credit Amount, I have no reason to worry? Unfortunately, it isn t that simple. If your Will contains trusts for beneficiaries who are US persons, or if you are a beneficiary under a trust of your spouse s Will, while you may not have an Estate Tax liability, you or your beneficiaries may have a US Income Tax problem if your Wills are not correctly drafted (see below). In addition, the Credit Amount may not stay at this generous level indefinitely. So on my death everything will pass to my spouse tax free won t it? That depends. If your spouse is also a US citizen then the Marital Deduction can be elected in respect of part or all of the estate so that it passes tax free. However, if your spouse is not a US citizen, then any value above the Credit Amount will be taxed. If your spouse is UK domiciled or the estate comprises high value UK assets then there will be double taxation over the two deaths ie US Estate Tax on the first death and UK IHT on the second death. So what do I do if my spouse is not a US citizen? If you leave your estate above the Credit Amount under your Will in a special form of trust to pay income for life called a Qualifying Domestic Trust (a QDoT), then the US Estate Tax can be postponed until your spouse s death. At this point, it can be offset against any IHT payable under the US/UK treaty. CONTACT If you have any queries please contact: Mark Summers, Partner Dominic Lawrance, Partner +44 (0) Lisa-Jane Dupernex, Solicitor +44 (0)

2 My children are well provided for so I want to leave my estate to my grandchildren, would that make good tax planning sense? In the UK, it would, but in the US, you have to be careful. The US has an additional Generation Skipping Transfer Tax (GST Tax) which is chargeable if a US person tries to bypass a living generation in this way. The tax is charged at an additional 40% but each US citizen is entitled to a personal exemption of in the region of US$5.25 million (adjusted to account for inflation each year). Again, carefully drafted Wills with suitable trusts can ensure that US citizen spouses make maximum use of their GST Tax exemptions. So can I simply make gifts during my lifetime to reduce my estate? Unfortunately, the US charges Federal Gift Tax on the US person making the gift. This is also charged at 40% on all lifetime gifts. A US citizen has a lifetime allowance of in the region of US$5.25 million (adjusted to account for inflation each year). This exemption is cumulative during a US person s lifetime and the amount used up is deducted from the Credit Amount available on death (in respect of Federal Estate Tax). The exemption amount may not remain at this generous level indefinitely. Once this exemption has been used up, it is gone forever; there is no equivalent of the UK Potentially Exempt Transfer (PET) regime under which gifts are exempt from UK IHT after 7 years. There is also a small annual gift allowance of in the region of US$13,000 (adjusted to account for inflation each year) per recipient; although this amount is small, great savings can be achieved as an unlimited number of recipients can receive these gifts each year. So perhaps I can just make gifts to my non-us citizen spouse to get value out of the US net of tax? Sadly, not. While gifts between US citizen spouses are tax exempt, a non-us citizen spouse is treated like any other recipient. There is, however, a rather more generous annual exemption of in the region of US$139,000 (adjusted to account for inflation each year) and which is in addition to the lifetime allowance. So if I am the family breadwinner and buy the family home in joint names with my non-us citizen spouse, I could be making a taxable gift? Absolutely. You should take advice at the earliest opportunity. It may be possible to rectify the position. In general, the US has rules that seek to attribute all of a jointly held asset to the US citizen spouse unless clear evidence can be provided to show that funds were provided by the non-us citizen spouse. I notice that you refer to the exemptions and allowances applying to US citizens. What about non-us citizens? The US is very nationalistic in applying its tax system. Non-US citizens receive far lower exemptions and allowances unless they have made the US their permanent home. This may apply to some but not all Green Card holders particularly if they are actually living in the US. Otherwise, for US Federal Estate Tax, the exemption is limited to US$60,000. There is no lifetime Gift Tax exemption, but non-us citizens can take advantage of the US$13,000 annual exemption. The limited exemptions can be an issue if non-us citizens own US real estate or shares. For married couples, the QDoT can be used in Wills to defer the US Estate Tax liability until the second death. 2

3 As I am non-uk domiciled, shouldn t I simply put all my non-uk assets in an offshore trust? No, in most circumstances you should usually be looking to establish a US domestic trust for tax planning. The US regards any trust that does not qualify as a US domestic trust (one that has a majority of US trustees and submits to the jurisdiction of the US courts) as foreign. This can even include a UK resident trust that pays UK tax! If a US citizen creates a foreign trust then he will still be liable to US Income Tax on all trust income and capital gains, even if he and his spouse are excluded from benefiting from the trust. The only exception is if the trust is specifically drafted so that no US person can ever benefit from it. There are also very stringent reporting requirements if a US person creates a foreign trust. My IFA says I should consider insurance based IHT planning such as a Gift and Loan Trust or Discounted Gift Scheme. No, you should not. Not only are any trusts used likely to be foreign trusts but the whole of the life insurance bond will not be recognized as life insurance by the US. At best, such schemes will achieve nothing for you but at worst you may land yourself and your family with an additional US tax liability and reporting requirements on an annual basis, whether or not withdrawals are taken. So I shouldn t be investing through an offshore bond or whole of life protection policy either? Absolutely right. At best, the US will simply disregard the life assurance wrapper and tax the underlying investments so it may not achieve a lot for you other than involve you in additional US reporting requirements. So are there any other investment types or structures that I should avoid? The main class of investment to avoid, if possible, is non-us collective investments. This would include UK authorised funds, non-uk (including Dublin or Luxembourg) distributor/reporting funds, hedge funds and the like. Particular care needs to be taken where you are considering an equity ISA as these often contain such collective investments. Realised gains on non-us collective investments are usually taxed at higher rates of US Income Tax. So what types of investment should I hold? From a tax perspective, the most appropriate investments would be discretionary managed portfolios of equities, bonds and cash. If you are non-uk domiciled and are taxed on the remittance basis (ie only taxed on UK income and gains and foreign income and gains that you bring to the UK), then the equities and bonds should be non-uk and you can consider US mutual funds and other US compliant investments, although these may not have a favourable UK tax treatment if you ever remit the proceeds of sale to the UK. Speaking of which, I am non-uk domiciled and have lived in the UK for 7 years, so I now have to pay the 30,000 charge to be taxed on the remittance basis. Should I pay this? This is a complex question which needs to be addressed in conjunction with an accountant who is experienced in both US and UK income tax matters. Whether you should pay the charge is not simply a question of your net worth or the amount of your non-uk income. It also depends on where your assets are located and their type. Some investments such as mutual funds and municipal bonds enjoy 3

4 much lower tax rates in the US than in the UK. It is also a question of how much of your foreign income and gains you expect to remit to the UK since the 30,000 charge is a price simply for enjoying a tax deferral until the taxable funds are remitted to the UK. Broadly, the 30,000 is not creditable against subsequent UK tax that you pay. In addition, please note that once you have lived in the UK for 12 years, the charge increases to 50,000. But surely I can get a credit for the 30,000/ 50,000 charge against my US Income Tax? The position was previously unclear but the IRS ruled in August 2011 that the 30,000/ 50,000 charge is creditable against US Income Tax. You may be able to obtain credit for previous years where you paid the 30,000/ 50,000 charge, but did not receive a credit against your US Income Tax, provided you are within the stringent time limits for reopening your US Income Tax returns. You should take advice in this regard at the earliest opportunity. I am selling my UK home. Is there any US tax due? Unfortunately, the US equivalent of Principal Private Residence Relief for capital gains is restricted to only the first US$250,000 of gain. US Income Tax is payable on gains above this level currently at a maximum rate of 20%, and you should report the sale to the IRS. Contrary to popular belief, it is no longer possible to roll over the gains into a new property. You should also bear in mind that the gains will be calculated in US Dollars. I am the beneficiary of a non-us trust. Do I have any US tax issues? Yes, you do. It does not matter whether the trust is UK resident or offshore. The US regards all foreign trusts in the same way and often taxes distributions to US beneficiaries harshly. Unless the US regards the trust as a grantor trust the US will seek to charge US Income Tax upon the US beneficiary receiving a distribution in respect of accumulated income and gains within the trust on which US tax will not have been paid. However, the US then applies the throwback regime to apply interest and penalties on the basis that had the trust been a US domestic trust, it would have paid the tax in an earlier year. With interest and penalties, the effective tax rate can be 100%. There are sophisticated strategies that can be employed to mitigate the problem. This punitive level of taxation arises even if the trust is UK tax resident and has paid UK income and capital gains taxes. Indeed it may not always be possible to claim a credit for such UK taxes against the US income due so there may also be double taxation! Are my children US citizens? If your children were born in the US and/or your spouse is also a US citizen, your children will automatically be US citizens by birth. However, even if your children were not born in the US and your spouse is not a US citizen, your children may nevertheless be automatic US citizens by birth depending on a number of factors including when they were born, whether you were married when they were born and how much time you spent in the US before they were born. It does not matter whether your children (or you on their behalf) have applied for US passports; US citizenship may be automatic in all of these circumstances. You/your children should take advice in this regard at the earliest opportunity. 4

5 These tax rules for US citizens seem pretty harsh. Do they apply to anyone else? Most US Green Card holders, some expatriates from the US and those who are tax resident in the US are also subject to some or all of the US s various taxes. Specific advice should always be sought. This all seems like too much trouble. Why don t I simply give up my US citizenship? You certainly can expatriate from the US. However, you should think long and hard before you do so. If a US citizen renounces their citizenship then they are deemed to dispose of their worldwide assets and are subject to a US Income Tax charge on any deemed capital gains. There are also further tax penalties imposed in the future if the expatriate makes a gift or legacy on death to a US person or receives a distribution from a foreign (non-us) trust. The only circumstances in which these harsh tax rules do not apply are if the person expatriating has an average income tax liability for the previous five years of less than in the region of US$151,000 (adjusted for inflation each year) or less than $2million of assets or is a dual national of another country by birth. If you think it likely that you will continue to travel regularly to the US then you should consider the issue very carefully since you may well run into difficult treatment with border control every time you visit and leave. You should also bear in mind that you need to hold another nationality before you expatriate. But if I don t live in the US and don t have any US assets then how are the US authorities ever going to find out about me? The IRS is regarded as the most aggressive tax authority anywhere in the world. It considers its jurisdiction to be global and compels banks and other financial service providers with any kind of US presence or connection to file forms in respect of accounts throughout the world. Since 1 January 2013, this reporting has become even more pervasive with the introduction of the Foreign Account Tax Compliance Act (FATCA). In practice, the IRS will catch up with you sooner or later. If you are caught, the penalties can be draconian. So what should I do? Come and see Speechly Bircham. We have a number of English solicitors, who while not formally US qualified, are US tax aware and can assist in resolving your tax and estate planning issues. We work closely with a number of leading US law and accountancy firms and have developed sophisticated estate planning documentation that can incorporate both US and UK tax saving techniques including the Speechly Bircham Wealth Protector. Quite apart from the tax savings, having a sophisticated Will in place can also protect family wealth against the threats of remarriage, new relationships, divorce and financial immaturity or vulnerability of any beneficiaries. So Speechly Bircham can provide US tax advice? No, we cannot. Although we can appraise your situation and suggest strategies, if you wish to proceed on any matter then we would seek to source specific qualified US advice on which you can rely which would be dove-tailed with our own advice. Our in depth understanding and experience of the US tax system means that we can be specific and focused in sourcing US advice and you do not end up paying for professionals re-inventing the wheel in blending it with UK and other tax advice to produce a complete and integrated solution. The advice in this note is itself only 5

6 generic; it cannot be relied upon and specific advice should always be sought. So how much is it all likely to cost? The advice that will need to be given in any particular circumstances will be bespoke and so it is always charged on a time spent basis. As you will appreciate, when two or more tax systems are being dove-tailed, the advice involved is very complex. However, the tax savings that can be achieved are very considerable. Estate planning for even the most straightforward US/UK married couple would usually cost at least 7,500 plus VAT but it can often be more depending upon the issues involved and the extent of the estate. The larger the estate, the greater the tax savings. CONTACT If you have any queries please contact: Mark Summers, Partner Dominic Lawrance, Partner +44 (0) Lisa-Jane Dupernex, Solicitor +44 (0) Legal insight. Commercial awareness. Personal service Speechly Bircham LLP is a limited liability partnership registered in England and Wales (registered number OC321620) and is authorised and regulated by the Solicitors Regulation Authority. A list of members names is open to inspection at our registered office, 6 New Street Square, London EC4A 3LX. This information is correct to the best of our knowledge and belief at the time of going to press. It is, however, written as a general guide, so we recommend that specific professional advice is sought before any action is taken. 6

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